When the Highest Rate of Return Isn't the Best

Whenever we talk about the TSP in the federal retirement classes I teach, people always ask, “What’s the best way to allocate my TSP?”

My answer usually surprises some and frustrates others.  My answer is…“In a way that helps you achieve your goals.”

I think this answer frustrates some people in class, because they want ‘the answer’.  They’re expecting a magic recipe of 20% in this fund, 10% in that fund, etc., etc.  They want me to be able to tell them the magic formula that gets the highest rate of return all the time and will work for everyone.  Some people are so caught up in looking for the ‘perfect’ allocation strategy and getting the highest rate of return that they lose sight of something very important.

But others in class have an ‘Ah-ha’ moment.

There is not one perfect allocation mix that is appropriate for everyone.  Why? 

What Are *Your* Goals?

The reason there isn’t one perfect TSP allocation is because we’re all different.  Your investments, including your TSP, need to be aligned in a way that makes sense for you. 

The way you allocate your TSP needs to reflect *your* goals.  Not Bob’s goals, and not the ‘average’ goals of someone your age.  *Your* goals.

Your goals are your destination.  Money is a tool to help you get there. 

When I first meet with clients, we talk about their goals.  Before we ever talk about investments, we get clear on their goals.  We talk about retirement goals, lifestyle goals, personal goals.  We discuss questions like, “When do you want to retire?  What sort of lifestyle do you want to live?” and more. 

Once we know what their goals are, then we look at how we can use money to achieve those goals.  Not the other way around. 

And after hundreds of these conversations, I’ve never had two that were exactly the same.  Every client is unique.  Everyone has different dreams, different desires, different goals.  The client’s individual goals drive their asset allocation. 

But when you don’t have clear financial goals in mind, you can end up chasing rates of return. 

Shouldn’t I Just Go For the Highest Return?

Some people think the ‘best’ allocation is the one that yields the highest rate of return. 

High returns are certainly wonderful – once you’ve received them.  But let’s step back and remember why investments pay high rates of return. 

In the big picture, investments pay a return to compensate you for the amount of risk that you take.  Investments pay a higher rate of return because you’re taking more risk.   Investments that are less risky pay less of a return.

When you’re investing in something that’s offering a high rate of return, it’s because you’re offering to take a high amount of risk. 

You’ve probably taken a risk tolerance test before – you answer a series of questions and the test tells you how much risk you’re ‘willing’ to take.  But just because you’re ‘willing’ to take a lot of risk – does that mean you *need* to?

Chasing Rates of Return

I want to share a real story about someone who forgot to focus on his goals, and ended up chasing rates of return.  (We’ve changed his name for this story and aren’t revealing any identifying personal details.)

He Had Enough Money When He Retired, But…

Bob was thinking about hiring a financial planner, and he contacted us right before he was retiring.  He had a good pension, and about $600,000 saved up in other personal investments (accounts like TSP, employer-sponsored plans, etc.). 

We talked, but he decided he didn’t want to hire us to help.  Bob decided he would rather just manage his own investments.  That was at the end of 2007. 

A little more than a year later, in early 2009, Bob called again. His $600,000 account was now worth only $50,000. Based on past rates of return, had put all of that money in international investments. 

He asked if he hired us now, could we help him stay retired.  We’re good, but there are some things we just can’t fix overnight. Bob’s fixed pension wouldn’t be enough maintain the lifestyle he wanted in retirement.  I had to tell Bob he needed to get another job. 

That’s certainly not the answer Bob was hoping to hear. But I don’t like to sugar coat things, and I think it would have been a disservice to tell him anything else. 

I still remember that phone call. I haven’t heard from Bob again, but he’s got to start saving for retirement all over again at age 58. At least Bob is still young and in good health, but I’m sure he didn’t dream of having to go back to work again after he retired.

The real shame of the situation was that Bob *had* enough money when he retired.  Between his pension and the $600,000 of personal investments…he had enough to live the lifestyle he wanted comfortably. 

If he had focused on choosing investments based on his goals, rather than just chasing the highest rates of return, Bob would probably still be retired today. 

But Bob lost sight of his goals. Instead of thinking about how much risk he *needed* to take, Bob got caught up in chasing rates of return. He forgot that high rates of return come with high risk, and it cost him his retirement.

Some people chase rates of return because they want ‘more’.  More, more, more – but what is more?  How much ‘more’ will be enough? 

Learn from Bob’s mistake, if you have enough money to retire, don’t get caught up in chasing rates of return.

Whether you’re working with a planner, or doing-it-yourself, remember your goals.  Before you choose your investment allocation, step back and take a look at your larger financial picture. 

© 2016 Micah Shilanski, CFP®. All rights reserved. This article may not be reproduced without express written consent from Micah Shilanski, CFP®.

About the Author

Micah Shilanski is a Certified Financial Planner™ professional who specializes in helping federal employees get the most out of their retirement benefits. Micah helps his clients with tax planning, retirement planning, federal retirement planning, estate planning, and investment advice.

Plan Your Federal Retirement is a dba of Shilanski & Associates, Inc., an Alaska Registered Investment Advisor, with securities offered through Summit Brokerage Services, Inc., Member FINRA/SIPC.

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